How to Play the Rebound in Housing

NEW YORK ( TheStreet) -- Gone are the campouts to get in line for the release of phase 2 of Canyon View Estates. Gone are the no money down, low-interest rate loans. Gone are the "if you can fog a mirror" loan qualifications. And gone is a whole a lot of equity in our homes.

Investors once again learned a very harsh lesson on valuation. Value does matter! Real estate had been appreciating at rates way beyond the norm for several years. Cheap money, loose lending practices and a horde of buyers chasing a dwindling supply of new homes created yet another value bubble that had to burst at some point.

And burst it did. Just ask the little town in Norway that had invested in U.S.-made mortgage-backed securities. Just ask the local real estate appraiser whose business all but dried up. Just ask Lehman Brother or Bear Steans. It was a very nasty popping of a very extended bubble.

I wrote an article for TheStreet back in October titled "This Housing Recovery is Real." You only have to look at the monthly Case-Schiller reports since then to determine if I was right or not. Home values or up over 20% in many market year over year.

The real estate market continues to come back. Many real estate-related stocks have been very good investments since the lows in the market back in 2009.

One of my biggest holdings at Gunderson Capital Management continues to be CoStar Group ( CSGP).

CoStar is a commercial real estate information and analytics provider. It was founded in 1987 to form a database of commercial real estate information in order to interpret values of properties and interpret market conditions.

The company provides real estate information services to brokers, property owners, developers, bankers, and government agencies. Current market capitalization is about $3.5 billion.

Data from Best Stocks Now App

This stock is a domestic small-cap growth company that would be suitable for growth investors. Small and mid-cap domestic stocks continue to be the leading asset classes among 35 that I track.

Data from Best Stocks Now App

Precious metals, emerging markets, inverse the market and bonds continue to be the worst asset classes in which to be invested. They have been cellar dwellers for almost one year now. I only invest in the best asset classes at any given point in time.

I determine the best ones by their short-term, intermediate-term and long-term performance. I also weigh their relative safety.

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Once I determine that small and mid-cap domestic stocks are a leading asset classs, I break it down even further and check for the leading sectors. The building and construction sector has been a leading sector in the market for about one year. It has sold off some with the recent hike in interest rates, but there are still some good stocks like CoStar within the sector.

I determine the best stocks by next requiring three criteria: strong performance, good value and a healthy stock chart.

Let's first look at the performance of CoStar Group. The best way to do that is to compare it to the S&P 500:

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As you can see, the stock has beaten the S&P 500 by a wide margin over the last 10-, five-, three- and one-year periods of time. Obviously, it has not been a straight line, however. When I compare the performance of the stock against the 3,404 stocks that I track, it earns a performance grade of A-.

The stock has also beat the market by a wide margin over the last one, three, and 12 months. It also earns a momentum grade of A-. The stocks meets my performance requirements.

I am not strictly a performance or momentum investor, however. I started this article with a lesson on valuation. I repeat again, valuation does matter!

Let's next take a look at the stocks current valuation:

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On the surface the stocks looks expensive with a forward PE of 43.3 and a PEG ratio of 2.17.

When I apply my five-year valuation formula to the stock however, I can still justify the shares being reasonable price. I come up with a five-year target price of $226 per share which gives the stock 86% upside potential.

I require 80% or more in order for a stock to meet my valuation criteria. CoStar currently meets my valuation requirement. The stock now meets my performance and valuation criteria, just one more to go.

Some investors are momentum investors. Some investors are value investors, and some investors are technical investors. I am all three. I combine them all. This really narrows down a large field of stocks.

The one-year chart of the stock is the final arbiter for me. I never buy stocks that are in downtrends, even if they meet the other two criteria. I don't like sideways or undecided trends. I wait for them to break one way or the other. I am also very wary of long, extended uptrends that are beginning to roll over.

I like charts that are breaking out of consolidations or are in very healthy uptrends.

I bought CoStar in late December of last year as it began to emerge out of its sideways base. I still own it. The stock is still in a very, very healthy uptrend. I would still buy CoStar today. It is currently one of the strongest stock in the entire market.

This stock passes my stock chart test, performance test and valuation test.

Of the 3,403 stocks that I grade and compare, this stock is currently ranked at number 21. I pretty much focus on the top 200 at any given point in time. As you can see, the stock has been in my top 200 for over six months.

If the stock starts to falter in performance, get too expensive or if the chart starts to roll over, I will move on. But for now, clients of Gunderson Capital Management are still long the stock.

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At the time of publication the author had a position in CSGP.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.